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When it comes to running a corporation, planning for the unexpected is just as important as day-to-day operations. One critical but often overlooked safeguard is a well-drafted shareholder agreement.

Imagine a scenario where a shareholder unexpectedly passes away or decides to retire. Without a well-drafted shareholder agreement, the shareholders could face significant legal and financial challenges and expenses. These include disputes over ownership and control, leading to costly legal battles; valuation disagreements requiring expensive external experts; and complications in exiting the company, which may result in prolonged negotiations or litigation. Additionally, the absence of clear buy-sell provisions can leave shareholders facing unexpected tax liabilities or difficulties in handling the death or disability of a shareholder.

Ownership of a corporation is held in shares of stock. Shareholders or stockholders have the right to, and as a best practice should, enter into a contract that clearly explains the rights and responsibilities of each shareholder. These contracts can outline ownership interests, employment and payment rights, distribution rights, access to corporate documents, and any other agreements the shareholders want to make.

Notably, shareholder agreements can also preemptively address what happens when a shareholder dies, retires, or otherwise wants to divest their shares. In a recent matter handled by CMM’s litigation team and led by litigation partner David Green, owners of a corporation’s shares spent significant resources litigating over the value of the corporation so that one shareholder could sell their shares. The shareholder’s agreement was silent on any valuation methodology.

In contrast, a shareholder’s agreement can include a specific formula to determine valuation, or even a specific value per share. Spending the time, money, and resources upfront to assess and plan for a share sale would have saved the client tens of thousands of dollars in the long run. This real-life example underscores the importance of proactive planning.

Moreover, minority shareholders may be at risk of oppression without adequate contractual protections, and unclear roles or compensation structures for working shareholders can lead to internal disputes. Finally, without defined ownership of intellectual property or company assets, shareholders could face costly legal conflicts.

Maintaining a comprehensive and up-to-date shareholder agreement is crucial for any corporation. The best practice for any corporate shareholder is to create and regularly assess your shareholder’s agreement.

Read more:
Annual Business Checkup: Preventing a Costly Business Divorce

For more input and guidance on business divorce, reach out to David Green at 631-738-9100.

Thank you to Alex Tomaro for his research and writing assistance.

The phrase “hope for the best, prepare for the worst” has Latin roots, tracing back to “si vis pacem, para bellum,” meaning “if you want peace, prepare for war,” emphasizing the need to be optimistic, but prepared.

In the context of business relationships, this mindset is especially relevant. Business relationships often begin with shared goals, trust, and mutual interests, but disagreements, changes in circumstances, or evolving visions can lead to disputes, and possibly business divorce. To avoid legal issues and financial strain, it is crucial to be proactive and prepared. Regular assessments of key corporate documents are essential!

For corporations, the bylaws are the rules that generally govern the operation of the business. However, specific agreements between the shareholders should be further fleshed out in a separate shareholder agreement. The shareholder agreement should address everything from management structure to shareholder rights and dispute resolution mechanisms. As legal landscapes and business and personal relationships evolve, outdated agreements can create complications, misunderstandings, and unnecessary disputes. Being proactive helps ensure that all parties are on the same page, ultimately making the navigation of working relationships, the dissolution process, and any other disputes more efficient and less contentious.

For LLCs or other business structures where ownership is shared, the operating agreement is the central document. Some crucial elements to review in this document are the terms for dissolution and buyouts. If a partner wants to exit, how is the buyout structured? Are there clear formulas in place, or will a third-party valuation be required?

For partnerships, a clear partnership agreement is the first line of defense against the fallout from a potential business divorce. A properly drafted partnership agreement should articulate roles, responsibilities, and expectations, and most importantly, provide clear mechanisms for withdrawal, dissolution, and valuation of the business.

Financial mismanagement or disagreements can lead to significant legal issues. Clear and transparent financial agreements help prevent such problems. Key items to review include debt obligations, liability distribution, profit-sharing models, and capital calls or funding expectations. These financial agreements should be revisited annually to reflect the business’s current financial standing and to ensure clarity over financial responsibilities and expectations.

A business divorce does not have to be a messy, expensive ordeal if business owners maintain clear, well-drafted agreements and regularly review their governing documents. A proactive approach to legal maintenance ensures that your business is protected from conflicts, liabilities, and potential complications. By preparing for the worst while hoping for the best, you can safeguard your business’s future and avoid the costly repercussions of neglecting to check up on important governing agreements.

Read more:
Annual Business Checkup: Shareholder Agreements

For more input and guidance on business divorce, reach out to David Green at 631-738-9100.

Thank you to Alex Tomaro for his research and writing assistance.